Monday, May 14, 2012

Take a look at the May 11, 2012 Associate Press article entitled “Calls to toughen regulation follow JPMorgan loss.” [http://news.yahoo.com/calls-toughen-regulation-jpmorgan-loss-212428437--finance.html] I do not expect you to completely understand the article and that is part of my point. The banking industry has become so tremendously complex that it is difficult for people, including bankers, to understand it. In their pursuit of profits, banks use intricate financial instruments with exorbitant risks (such as derivatives and credit default swaps) and they use savvy legal techniques to disguise those risks. Most analysts put much of the blame for the economic decline of 2007-2009 (from which we have not yet fully recovered) on excessively risky lending practices by banks due in part to insufficient regulation of financial markets and the use of complex financial instruments that are not completely understood.

Banks have spent vast sums of money lobbying politicians to reduce regulations of financial markets or to create loopholes that make regulations less effective. JPMorgan Chase, the largest U.S. bank, is widely considered to have one of the most knowledgeable and effective management teams with a chief executive officer, Jamie Dimon, who boasts of the bank’s exceptional understanding of risk management. So the report that JPMorgan Chase recently lost $2 billion in six weeks pursuing an aggressive investment strategy has reignited concerns that bank actions could lead to another financial crisis that might have a devastating effect on the global economy and potentially require another hefty bailout by U.S. taxpayers. The rationale for the taxpayer-funded bank bailouts begun under President George W. Bush and continued under President Barack Obama is that financial markets have become dominated by a few giant banks that are “too big to fail.” Mainstream economists are in general agreement that there were mistakes in the design and implementation of the recent bank bailout packages, but the global economy would be in significantly worse condition if the U.S. government had not taken action to prevent a larger financial collapse.

Many analysts suggest that the problem of banks being “too big to fail” is a direct result of the removal of government restrictions that previously limited the scope of an individual bank’s activities (e.g., by not allowing a typical commerical bank that lends money to households and small businesses also to be an investment bank that engages in risky, speculative behavior) and the removal of laws that limited the size of banks by not allowing them to operate across state lines. In essence, if laws and regulations prevented banks from becoming “too big to fail,” then we could allow the ones that engage in risky behaviors to go out of business without having a huge negative impact on the global financial system.

The new suggestions that financial markets need increased supervision are part of a much larger debate about government regulation. This is another area is which the perspectives of mainstream economists differ significantly from many politicians, business leaders, and voters.

Many people talk about free markets as if they are intrinsically superior to the alternatives. Politicians profess support of free markets as a moral virtue and they imply that government intervention or interference with business activities is unquestionably detrimental to society. U.S. politicians who advocate regulation are ridiculed as un-American. The fundamental flaw with this reasoning, however, is that despite claims to the contrary, almost nobody believes in free markets. In a truly free market, laws, rules, and regulations do not inhibit, restrict, or prevent any transactions for which there are willing buyers and sellers. The phrase “free market” refers to a market that is free of government regulation and intervention. But most people, including libertarians, readily agree that it is appropriate for society to have laws and rules that restrict many market activities. For example, most people support laws that prevent children from purchasing alcohol, tobacco, and firearms. We do not think parents should be allowed to use their children as prostitutes. We want there to be restrictions on the sale and distribution of (at least some) drugs. Most people agree that slavery should be illegal and humans should not be allowed to sell body parts. All of these are government interventions in markets. Since almost everyone agrees with these policies, it is reasonable to conclude that almost everyone thinks the regulation of markets is appropriate.

Society needs to discuss market regulation. But the debate needs to be about which types of regulation are appropriate for different markets, not whether regulation is intrinsically evil. It is fair for people to disagree about the extent to which certain market activities should be allowed. However, it is hypocritical to cite individual liberty as the basis for less gun control, but then to argue against a woman’s freedom to terminate an unwanted pregnancy. I am not taking sides on these controversial issues. Instead, I am suggesting that whichever side you prefer, you need to make better and more persuasive arguments for your position. It is not sufficient to use liberty and freedom as the only justification for less gun control or the right to choose an abortion. Everybody believes in liberty to a certain extent and we all believe in the restriction of freedoms in some situations. We agree that individuals should have the freedom to choose where they live and they should be allowed to apply for whatever jobs they want. And we agree that people should not have the liberty to kill each other or to steal another person’s property. However, there are numerous situations in which people disagree about the relative importance of individual freedom versus potential effects on others in society. For example, opponents of gay marriage suggest that redefining marriage to include homosexuals has negative societal effects that outweigh the freedom of those individuals to choose a marriage partner. Supporters of gay marriage weigh those effects differently, thinking the freedom to choose one’s legal partner is more important.

There are some market outcomes that can be improved by government regulation. For example, regulations implemented since the 1960s have reduced the degree and scope of pollution in the United States. And although regulations are not intrinsically evil, they also are not instrinsically good. Some regulations make markets less competitive, protect special interests, or have other negative results. Society should not vilify the regulation of markets, but instead seek to improve rules and restrictions (increasing some and decreasing others) to obtain the desired results.

Mainstream economists believe markets should be competitive, but it is not important that they be free of regulation. Instead, economists believe better social outcomes occur when markets have a sufficient number of buyers and sellers so that nobody is able to exert undue control or influence over the market. In many cases, government regulation is the key to keeping markets competitive. For example, the U.S. typically does not allow one company to buy all of its competitors so that there is only one producer of a product. These restrictions against monopolies are designed to protect consumers because monopolies tend to charge significantly higher prices than similar markets with competition.

Saturday, February 25, 2012

A mathematician, an accountant and an economist apply for the same job.

The interviewer calls in the mathematician and asks "What do two plus two equal?" The mathematician replies "Four." The interviewer asks "Four, exactly?" The mathematician looks at the interviewer incredulously and says "Yes, four, exactly."

Then the interviewer calls in the accountant and asks the same question "What do two plus two equal?" The accountant says "On average, four - give or take ten percent, but on average, four."

Then the interviewer calls in the economist and poses the same question "What do two plus two equal?" The economist gets up, locks the door, closes the shade, sits down next to the interviewer and says, "What do you want it to equal"?

Economists (and very few others) find this joke funny because it is very revealing about how economists are used in the real world. Working for the Congressional Budget Office (CBO) is one of the rare jobs in which politicians ask economists to provide a complete analysis of an issue. In most cases, politicians hire economists to provide evidence to support pre-existing narratives. For example, a colleague worked as an economist for the State of Wisconsin when Tommy Thompson was its governor. There was some discussion among legislators about increasing the minimum wage. Rather than going to the staff economists and asking for a complete analysis of the proposal (seeking the pros and cons of the issue), Governor Thompson's staff asked simply for economic arguments against raising the minimum wage. The governor had decided his position on the issue without having full information. Indeed, he did not want a complete analysis. He just sought support for the belief he had formed without all the facts.

This is typical of how politicians across the political spectrum use economists. They treat them as hired guns, rather than the objective analysts they are capable of being. This is one of reasons why economists in the media may seem to contradict each other. They may be presenting different sides of the issue. But neither is providing the whole truth. One of my primary goals as a teacher is to help people to see "the truth, the whole truth, and nothing but the truth" about macroeconomic issues.

Unfortunately, the baby boom generation – my generation – may not be remembered so fondly.An appropriate description for those of us born between 1946 and 1964 might be “The Most Selfish Generation.”I say this because of the wreckless fiscal irresponsibility we have demonstrated over the past 31 years.

Take a look at the red graph below.

At the end of 1980, the U.S. public debt was less than 1 trillion dollars.That means from the creation of this nation through 1980, the entire net accumulated amount of money borrowed by the U.S. federal government was less that 1 trillion dollars.

In 1981, about the time that baby boomers became leaders in both the public and private sectors, public policies were implemented that have led to a current public debt that exceeds 15 trillion dollars.So in the past 31 years, while baby boomers have been running things, the U.S. public debt has increased by more than 14 trillion dollars.In other words, over the past three decades, the United States has consumed 14 trillion dollars of government services we have not paid for and that we will pass to future generations.

For those of you who were born after 1964, I have two words for you …. You’re welcome.…. 15 trillion dollars of debt (and still counting) … that’s our gift to future generations.

To be fair, money borrowed today does not have the same purchasing power as the dollars of the past.So let’s take a look at the purple illustration below.

When the public debt is adjusted for inflation, the diagram illustrates my case even better.In the first 200 years of U.S. history, the federal government paid its bills (for the most part).In some years we ran modest deficits (you can see the big bump to pay for World War II), but we usually paid our bills.This changed in 1981 when taxes were cut under the leadership of President Ronald Reagan, but there was NOT a corresponding decrease in government services.The ultimate irony is that in his 1981inaugural address, President Reagan warned of the dangers of public debt, saying:

For decades, we have piled deficit upon deficit, mortgaging our future and our children's future for the temporary convenience of the present. To continue this long trend is to guarantee tremendous social, cultural, political, and economic upheavals.

Yet, Reagan helped create a culture of hypocrisy in which we complain about public debt, but seem to continually demand further tax cuts while steadfastly refusing to sacrifice any of the government benefits we expect.

The military conflicts of the past decade in Iraq and Afghanistan are the first time in U.S. history that we have cut taxes in a time of war.When men and women of mostly younger generations are sacrificing their lives for our country, we – the baby boomers – refuse even to pay the financial costs of supporting them – choosing instead to pass the costs to our children, grandchildren, and future generations.And let’s not forget that while reducing federal government revenues through the Bush tax cuts of 2001 and 2003, we also greatly expanded the size and scope of the U.S. federal government through the implementation of Medicare Part D which subsidizes the costs of prescription medications.

The diagram above illustrates the U.S. public debt as a percentage of gross domestic product.It shows our debt in relation to our income.Richer countries and richer people can afford more debt than poorer ones.But even by this measure, the wrecklessness of baby boomer public policies is evident.

You may notice in this graph, as in the previous two illustrations, that there is a decrease in the U.S. public debt in the late 1990s.It is natural and normal for there to be ups and downs in economic activity over time.Economists call this the business cycle.And the surpluses of the late 1990s correspond to being in a properous part of the business cycle.But these budget surpluses were primarily the result of the short-term willingness of Congress to impose on itself pay-as-you-go (PAYGO) rules that require any new spending to be funded by increased revenues or offset by reductions in other expenditures.But as yet another example of baby-boomer selfishness, these rules were abandoned in 2001 (fiscal year 2002) to allow for the popular tax cuts and the subsequent increases in government expenditures.

(5) Other programs supported by both the Bush & Obama administrations, such as the Iraq war and a patch for the alternative minimum tax (- $232 billion)

(6) Stimulus spending (- $145 billion), and

(7) Other Obama programs (- $56 billion).

A July 2011 diagram (above) from The New York Times series, "Charting the American Debt Crisis," shows (on the right) how much of the $14.3 trillion debt (at the time) was accumulated under each U.S. President and (on the left) who holds the debt.

And it is worth noting that most of those who are raising the alarm about this debt issue, are not proposing solutions that involve sacrifice by baby boomers.Indeed the refrain is that those of us at or near retirement will not receive any reduced benefits from Social Security or Medicare.The proposed reforms will reduce benefits for younger people.

Once again, I say to people born after 1964 … You’re welcome!

There is one notable exception among the voices for fiscal reform who offers a chance at redemption for baby boomers, if you want to call it that.

David Stockman, President Ronald Reagan’s budget director, advocates a one-time surcharge on the wealthy.He explains the idea in an interview he did for 60 Minutes in October 2010. Click the link above to find the interview or simply search for “David Stockman 60 Minutes.”

Sunday, February 5, 2012

The Obama administration feels the President's jobs record is being distorted by his Republican opponents. The Democratic Party distributed this information to try to set the record straight. The data are from the U.S. Bureau of Labor Statistics (BLS), the government agency that calculates and publishes the official record of labor market activity.

Note that this graph is for private sector jobs. If you take a closer look at the monthly labor reports you will see that government employment has been decreasing during much of this period. In other words, if the number of federal government jobs were not decreasing, the employment situation would be even better.

There is a legitimate debate to be had about the extent to which current policies have helped or hindered economic recovery. The Congressional Budget Office (CBO), the government agency of professional economists who advise all members of Congress about the impact of proposed policies, has consistently reported that recent government stimulus spending has aided the economic recovery and has improved U.S. employment from what it would have been in the absence of such spending. It is not a popular message with the opponents of the President. But it is consistent with mainstream economic theory.

Nonfarm payroll employment rose by 243,000 in January, and the unemployment rate decreased to 8.3 percent. Job growth was widespread, with large gains in professional and business services, leisure and hospitality, and manufacturing.

You Want the Truth?

Comments

I welcome comments. Please keep them civil, short and to the point. Obscene, profane, abusive and off topic comments will be deleted. Repeat offenders will be blocked. Thanks for taking part — and abiding by these simple rules.

The following information is provided to help you understand the biases that may be inherent in this blog.My primary U.S. economic policy concern is the fiscal irresponsibility of government.The Baby Boom generation, which I am part of, has spent the past 30 years accumulating massive public debt that will be passed to our children, grandchildren, and subsequent generations.I am not opposed to the reduction or elimination of any government spending program.Yet, politicians tend to call for reduced spending in general terms and fail to publicly declare specific cuts they would make.The primary cause of the massive U.S. public debt is revenue reductions (in the form of tax cuts) without similar decreases in government spending.

I am willing to consider the expansion and addition of government programs as well.I do not mind how much or little the government provides to society as long as it is paid for.I am willing to pay higher taxes for services deemed worthy, whether they be national defense, homeland security, or income assistance to those less fortunate than I.And I am certainly willing to pay less in taxes or to deposit any government check I receive.My generation, the Baby Boomers, has been very good at cutting taxes and increasing the size of government, regardless of which political party is in power.This is a prescription for financial chaos that remains a horrible legacy for future generations.

About Me

I am a professor of economics at Jacksonville University, where I teach courses in introductory economics, comparative economic development, and globalization. I use this blog to keep in touch with my current and former students. Teachers and students at other schools, as well as others interested in economic issues, are welcome to use this resource.